How Western Multinationals Are Responding to the Escalating U.S.-China Trade War

Executive Summary

Companies whose value chains depend on China now face increased political risk. Chinese suppliers and their sub-contractors are susceptible to pressure to behave ‘patriotically’ when authorities convey the message, however tacitly, that lack of cooperation with foreign multinationals is in the national interest. Companies need to take urgent steps to measure their potential exposure. Doubling up value chains, including alternatives outside China, would mitigate the risk of political and regulatory disruption. (It would also have the added benefit of providing insurance against ever-more-frequent natural disaster.) Some forward-looking companies, particularly those whose vulnerable to U.S. national security concerns because they incorporate Chinese technology into their end products, have started to reconfigure their value chains where possible.

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The furious reaction from China to the arrest of Huawei’s chief financial officer, Meng Wanzhou, in Canada at Washington’s request immediately raises the prospect of like-for-like retaliation against executives from North American companies, a fear reinforced by the arrests of a former Canadian diplomat-turned-NGO-researcher and a Canadian businessman.

Western business people are ensnared in low-level court proceedings in China far more regularly than is reported in the West, the risk remains low of a retaliatory move against a Western executive of similar status to Meng. It would undercut the high-ground that Beijing has occupied as self-appointed defender of “the rules-based international order.”

However, there are other ways for Chinese authorities to take reprisals against Western multinationals operating in China should they so choose. Day-to-day business operations can readily be interrupted through inspections, audits, and other tourniquets of red tape, and by the selective application of the letter of Chinese civil, administrative and criminal law. There’s also the possibility of travel bans on executives (including on those under unresolved court proceedings), and good, old-fashioned intimidation.

Add to this the current trade tensions between the U.S. and China and Western multinationals — such as the big U.S. technology companies — that use China as a source of assembly, semi-manufactures or components have an additional vulnerability: their value chain.

For every such company, especially those critically reliant on Chinese sub-contractors, their value chain is now actively at increased political risk. Local suppliers and their sub-contractors are susceptible to pressure to behave “patriotically” when authorities convey the message, however tacitly, that lack of cooperation with foreign multinationals is in the national interest. Something similar has occurred when Chinese consumers have on earlier occasions read the signals for when they were meant to boycott Japanese and South Korean products.

There are many ways to apply informal pressure along the value chain from delaying delivery to the easing of quality standards. Suppliers and subcontractors could find themselves suffering sudden and “unexpected” shortages of inputs and disruptions from labour.

Companies need to take urgent steps to measure their potential exposure. Doubling up value chains, including alternatives outside China, would mitigate the risk of political and regulatory disruption. (It would also have the added benefit of providing insurance against ever-more-frequent natural disasters.) In our analysis and consulting work, we have come across some forward-looking companies that have started to reconfigure their value chains where possible – particularly those who are vulnerable to U.S. national security concerns because they incorporate Chinese technology into their end products.

Doing so is neither necessarily easy nor cheap. China has accumulated a vast manufacturing ecosystem servicing foreign companies, encompassing everything from hard infrastructure to soft skills. Its growth has accelerated in recent years as China has embraced automation as way to offset rising wages that could make it less competitive as an offshoring center.

For that reason, building up a parallel value chain is not simply about shifting to another low-wage country. Both the quality and quantity of China’s manufacturing skills, particularly in the areas of automation and robotics, deter companies from relocating from China to elsewhere in South or Southeast Asia. Lower-wage countries like Vietnam and Cambodia have little spare production or skilled human capacity left, even in relatively low-skilled sectors like textiles and garments, let alone the advanced precision tooling, materials handling, and process engineering and development skills that a U.S. technology company needs. Nor do those countries have the resources to develop them rapidly.

Tim Cook, chief executive of Apple, a company so committed to manufacturing in China that it labels many of its products, “Designed in California. Assembled in China” recently noted that if he called a meeting of all the tooling engineers in the U.S., he wouldn’t fill a room, whereas in China he could fill multiple football fields.

Regardless of these impediments, and even before the heightened trade tensions between China and the U.S., there was business logic to the case for value-chain diversification — and a parallel process of value-chain reconfiguration already underway in some sectors with a regional focus. Production of end-products and components — ranging from bicycle parts to computer hard drives — has started to relocate, with low-tech production shifting from China to Indonesia, Cambodia, Bangladesh, and India, and higher-tech ones moving to South Korea, Taiwan, Singapore, and Malaysia. Vietnam straddles the two.

Burgeoning middle-classes in South and Southeast Asia provide a growing market for China’s consumer and industrial goods, especially for non-luxury goods that do not need the cache of a U.S. or European brand. Countries such as India, Indonesia, Malaysia, the Philippines, and Thailand are all forecast to be among the 20-25 largest economies during the second quarter of this century. Moving production nearer to those markets makes sense.

At the same time, for other Asian nations, China is starting to look like the “market of last resort” for selling what they manufacture. The U.S. has been that market been since the Second World War. But the Trump administration’s “America First” policy, with its emphasis on domestically produced goods, seems to put that in doubt.

Chinese companies, too, will be compelled to seek alternatives to the U.S. in response to Trump’s tariffs, especially those that have become U.S.-reliant, further accelerating the changes to regional trade and the value chains that support it.

The overall effect will be that more value chains will begin and end in China rather than beginning in China and ending in the U.S. There will be fewer global value chains and more regional ones.

Regional value chains do have an advantage: they are shorter than global ones. As global value chains have gotten longer and leaner, they have also grown more fragile, just as the pressures on them are increasing from technological change — particularly AI, robotics and big data, shifting relative labor costs, environmental concerns, such as carbon footprints, and reputational exposures.

The Trump administration’s trade policies will provide new impetus to the developing patterns of multiple, shorter regional value chains, but the transformation will not happen overnight. Value chains cannot be reconfigured any more quickly than a manufacturing plant can be rapidly rebuilt. Companies will hesitate to jump into new developing markets where investment laws can be unclear or nascent — like Myanmar, Cambodia, or Vietnam — and where labor and environmental standards lax. Nor will it be easy to replicate established relationships with factories, suppliers, and governments.

Complicated electronics value chains, in particular, are so entrenched in China, it is unlikely that all business will shift away from the country as a result of the new tariffs alone. For its part, China itself is still dependent on specific imported technologies such as chipsets and sensors. This constraint will ease as China develops, with some urgency, local capacities in these technologies, not least because the U.S. is set on preventing the export of crucial U.S. technologies and blocking Chinese companies from gaining access to them through inward foreign direct investment.

One scenario is that the current U.S. counter to China’s “strategic competition” — tariffs and technology export and investment controls — will further fracture value chains as it will lead to a dual global technology world with one part running U.S. technology on U.S. technical standards and another running Chinese technology on Chinese standards.

There would be no certainty that the hardware, software, and services of these two worlds would be interoperable, and, once a market is locked into one or other of the systems, it would be difficult for users to switch. This would add complexity to value chains, making it more likely they would default to specializing regionally.